When an owner of Unquoted share ("Shares") in a Company transfers the shares to any person, he is required to pay Capital Gain tax on the difference between the sale consideration received by him and the cost of acquisition of such shares (or the inflation indexed cost, wherever applicable).
It is important to check if the "Sale consideration" that he receives from the buyer is at least equal to or more than the "Fair Market Value" ("FMV") as defined under Rule 11UA of The Income Tax Rules, of the shares sought to be transferred.
As defined under Rule 11UA, the fair market value of unquoted equity shares shall be the value, on the valuation date, of such unquoted equity shares as determined in the following manner under (a) or (b), at the option of the assessee, namely; -
The fair market value of unquoted equity shares shall be calculated simply by ascertaining "Book value of Assets (Less) Book value of Liabilities."
- For ascertaining the book value of
assets, following amounts shall be excluded:
- Advance Tax, Tax deduction or collection at source or any amount of tax paid as reduced by refund claimed under the Income Tax Act.
- any unamortized amount of deferred expenditure which does not represent the value of any asset.
- For ascertaining the book value of
liabilities, following amounts shall be excluded:
- the paid-up capital in respect of equity shares;
- the amount set apart for payment of dividends on preference or equity shares
- reserves and surplus, by whatever name called, even if the resulting figure is negative, other than those set apart towards depreciation;
- any amount representing provision for taxation, other than amount of tax paid as reduced by the amount of tax claimed as refund
- any amount representing provisions made for meeting liabilities, other than ascertained liabilities;
- any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares.
The fair market value of the unquoted equity shares as determined by a Merchant B anker as per Discounted Free Cash Flow Method. Earlier, a Chartered Accountant was also permitted to determine the FMV of such equity shares. However, with effect from 24th May 2018, this right of Chartered Accountant is taken away and therefore only Merchant Banker is authorised to determine the FMV of such equity shares.
If the transaction of transfer of shares takes place at a price which is less than the FMV, there is a tax impact both on buyer of the shares as well as the seller. The legislation has made an attempt to In order to ensure the full consideration is not understated in case of transfer of unlisted shares, section 50CA
Impact of Tax on Seller – Section 50CA:
If the seller receives sale consideration on sale/transfer of unquoted equity shares which is less than the FMV of such shares, the FMV of such shares shall be deemed to be the Sale consideration received or accrued on such transfer of shares. Therefore, while computing the Capital Gain on transfer of shares, FMV of share will replace the actual sale consideration on transfer of such shares. The seller, in such case, will have to pay Capital Gain tax on difference between FMV of the shares and cost price (or the inflation indexed cost price, as the case may be) of such shares.
Impact of Tax on Buyer – Section 56(2)(x):
If the buyer acquires unquoted equity shares from a seller which is less than the FMV of such shares, the difference between the FMV of the shares and actual price paid by the buyer (in so much as it exceeds Rs. 50,000/-) will be taxable in the hands of the buyer under the hear "Income from Other Sources."
It is important to note here that both these sections are applicable only when the seller or the buyer, in respective cases, holds the shares as Capital Asset ie. As Investment. This is not applicable when the shares are held as Stock in Trade.
Any such shares received (by the buyer) under the following circumstances would be outside the ambit of section 56(2)(x) -
- from any relative; or
- on the occasion of the marriage of the individual; or
- under a will or by way of inheritance; or
- in contemplation of death of the payer or donor; or
- from any local authority; or
- from any trust or institution referred to in section 10(23C); or
- from any trust or institution registered under section 12AA; or
- by way of transaction not regarded as transfer under specific circumstances as stated under Section 47; or
- from an individual by a trust created solely for the benefit of relative of the individual.
Section 49(4) – diluting impact on buyer:
In the event when under section 56(2)(x), the buyer is charged to tax on the difference between the FMP of the shares and the actual price paid by the buyer, Section 49(4) comes to the rescue of such buyers. According to this section, whenever this buyer sells these shares, the cost of acquisition will be taken to be value which has been considered for the purpose of Section 56(2)(x). Thus, the buyer will be saved from double taxation on the differential amount.
Interplay between section 50CA & section 56(2)(x)
Example 1: -
Buyer: - A Seller: - B
A purchased 100 shares of unquoted company from B @ Rs.600/- per share. Thus, total consideration is Rs. 60,000/-. B had acquired these shares @ Rs. 500/- per share i.e. Total cost of Rs. 50,000/-. Current FMV is say Rs. 700/ Share.
Impact u/s 49(4): -
When A subsequently sell shares at (say) Rs.800/- (which is also the FMV):
|FMV of shares (when sold)||80,000|
|Less: - FMV of shares (when purchased)||(70,000)|
Thus, although the actual purchase price for A was only Rs. 60,000/- (but he had paid tax on FMV of Rs. 70,000/-), he will be able to claim Rs. 70,000/- as cost of shares whenever he sells these shares.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.